Crack spread option pricing with copulas

Hemantha Herath (), Pranesh Kumar () and Amin Amershi ()

Journal of Economics and Finance, 2013, vol. 37, issue 1, 100-121

Abstract: A copula-based approach for pricing crack spread options is described. Crack spread options are currently priced assuming joint normal distributions of returns and linear dependence. Statistical evidence indicates that these assumptions are at odds with the empirical data. Furthermore, the unique features of energy commodities, such as mean reversion and seasonality, are ignored in standard models. We develop two copula-based crack spread option models using a simulation approach that address these gaps. Our results indicate that the Gumbel copula and standard models (binomial, and Kirk and Aron ( 1995 )) mis-price a crack spread option and that the Clayton model is more appropriate. We contribute to the energy derivatives literature by illustrating the application of copula models to the pricing of a heating oil–crude oil “crack” spread option. Copyright Springer Science+Business Media, LLC 2013

Keywords: Copulas; Non-linear Dependence; Crack Spread Options; Energy Derivatives; Oil and Gas; Risk Management; C: Mathematical and Quantitative Methods (search for similar items in EconPapers)
Date: 2013
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DOI: 10.1007/s12197-011-9171-1

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